Economic Freedom and Employment Growth in U.S. States

Article excerpt

The authors extend earlier models of economic growth and development by exploring the effect of economic freedom on U.S. state employment growth. They find that states with greater economic freedom-defined as the protection of private property and private markets operating with minimal government interference-experienced greater rates of employment growth. In addition, they find that less-restrictive state and national government labor market policies have the greatest impact on employment growth in U.S. states. Beyond labor market policies, state employment growth is influenced by state and local government policies, but not the policies of all levels of government, including the national government. Their results suggest that policymakers concerned with employment should seriously consider the degree to which their own labor market policies and those of the national government may be limiting economic growth and development in their respective states. (JEL H70, O20, O51, R58)

Federal Reserve Bank of St. Louis Review, January/February 2011, 93(1), pp. 1-18.

Large differences exist in the economic growth and development of countries around the world. An extensive literature finds numerous factors that, taken together, explain why certain countries experience greater rates of income and employment growth than others. The most-cited factors contributing to economic growth include the stock of human capital, investment in technology, specialization and foreign direct investment, and low levels of political corruption.1 In addition to these factors, a more recent literature has explored the role of economic and political tutions in the economic growth of countries. Studies have shown that countries with greater economic freedom - meaning the protection of private property and private markets operating with minimal government interference - have greater rates of economic growth than countries with lower levels of economic freedom (Cole, 2003; Sturm and De Haan, 2001; Powell, 2003; Gwartney, 2009).2

Differences in economic growth (as measured by income and employment) also exist across subnational jurisdictions (e.g., states, provinces). For example, average annual employment growth in the United States from 1960 to 2008 was nearly 2 percent, but employment growth in individual states was much different - ranging from 0.8 percent in New York to nearly 5.5 percent in Nevada. In addition, the average annual per capita income growth for the 10 Canadian provinces from 1981 to 2008 was 4.3 percent, but the growth rates for individual provinces ranged from a low of 3.8 percent in British Columbia to a high of 5.3 percent in Newfoundland and Labrador.3

Many factors that explain differences in crosscountry growth also explain differences in state economic growth. Crain and Lee (1999) and Garrett, Wagner, and Wheelock (2007) have shown that income growth is higher in U.S. states with greater industrial diversity, a greater percentage of the population with a college degree, a greater percentage of the population in the labor force, and state government as a smaller share of gross state product (GSP). Tomljanovich (2004) demonstrated that higher state tax rates reduce state economic growth (measured by per capita GSP) for several years following a tax increase.4 Similarly, Nickell, Nunziata, and Ochel (2005) and Daveri and Tabellini (2000) found that higher labor taxes reduced employment. Finally, Quan and Beck (1987) and Nistor (2009) found that states and counties with greater human capital investment (i.e., education) had lower unemployment rates and greater employment growth.

It is reasonable that differences in economic freedom across states may explain variation in the growth of U.S. states as well. Economic and political institutions, such as business regulation, taxation, and government spending, differ across state governments just as they do across national governments. To date, however, empirical models of state economic growth have essentially ignored the potential role of state economic and political institutions in state-level economic growth. …